Project Cost Management

Chapter 7 – Information Technology Project Management

EECS 811 – Spring 2014

University of Kansas

Alex Oyler

1

Roadmap

• Introduction and case study overview

• Principles of cost management

• Estimating costs

• Determining the budget

• Controlling costs

• Software and tools

2

Roadmap

• Introduction and case study overview

• Principles of cost management

• Estimating costs

• Determining the budget

• Controlling costs

• Software and tools

3

Case Study

• Modernization of the Fiat 500e• Support TCU upgrade• Telematics infrastructure

• Cost factors• Non-recurring engineering (NRE)• Development• Integration and testing• Post-launch support

• The product• http://www.fiatusa.com/en/mobile_apps

/fiat-access/

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The Problem

• Most projects encounter overrun• Additional percentage or dollar amount by which actual costs exceed

estimates

• 27% average overrun for IT projects (Harvard Business Review, 2011)

• Measuring overrun isn’t always scientific• and neither is management of a project’s costs

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What Went Wrong

• United States Internal Revenue Service (IRS) is a prime example of how not to manage costs

• A series of failures in the 90’s cost taxpayers >$50 billion

• GAO (2008) reports more than 400 gov’t projects suffer from poor planning and underperformance• Total cost of those projects: $25 billion

• United Kingdom National Health Service electronic payments system• $26 billion overrun over 10 years

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Cost

• Cost is defined as a “resource sacrificed or foregone to achieve a specific objective” (Cost Accounting)• Money

• Time -> Money

• Project managers must understand project cost management in order to effectively control these tangibles

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Project Cost Management

• Recall the triple-constraint (right)

• Project cost management includes the processes required to ensure that a project team completes a project within an approved budget

• Endgame: satisfy stakeholders

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Processes of Cost Management

• Estimating costs – developing an approximation/estimate of the costs of the resources needed to complete a project

• Determining the budget – allocating the overall cost estimate to individual work items to establish a baseline for measuring performance

• Controlling costs – controlling changes to the project budget

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Figure 7-1: Project Cost Management Summary

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Case Study - Processes

• Cost estimation based on empirical data

• Budget determination based on cost of service, hardware, and labor rate

• Cost controlling based on regular level of effort reporting against baseline

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Roadmap

• Introduction and case study overview

• Principles of cost management

• Estimating costs

• Determining the budget

• Controlling costs

• Software and tools

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Profits

• Profits are revenues minus expenditures

• Profit margin is the ratio of revenues to profits• Example: $100 revenue generates $2 profit

• 2% profit margin

• Deduction: $98 invested

• Executives primarily concerned with profits

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Life Cycle Costing

• Life cycle costing allows you to see a big-picture view of the cost of a project throughout its life cycle

• Considerations:• Total cost of ownership

• Development plus support costs

• Project managers must make estimates of the costs and benefits of a project throughout its life cycle

• Life cycle cost should emphasize spending up front to reduce defect repair costs after implementation

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Cost of Downtime for IT Applications

Source: The Standish Group International, “Trends in IT Value,” www.standishgroup.com (2008).

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Cash Flow Analysis

• Cash flow analysis is a method for determining the estimated annual costs and benefits for a project and the resulting annual cash flow.• Used to determine NPV (net present value)

• Cannot have too many concurrent projects with high cash flow needs• Example: Network Vision

• Capital expenses

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Tangibles vs Intangibles

• Tangible costs/benefits are those costs or benefits that an organization can easily measure in dollars• Example: it costs $100,000 to perform internal labor on a project versus

$75,000 to outsource

• Intangible costs/benefits are costs or benefits that are difficult to measure in monetary terms• Examples: goodwill, political capital, prestige

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Costs

• Direct costs are costs that can be directly related to producing the products and services of a project

• Indirect costs are costs that are not directly related to the products or services of the project

• Sunk cost is money that has been spent in the past

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Learning Curve Theory

• Learning curve theory states that when many items are produced repetitively, the unit cost of those items decreases in a regular pattern as more units are produces.

• Factors:• Domain knowledge

• Relationships

• Lessons learned

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Case Study – Costs and Curve

• Direct costs: NRE for modem manufacturing, interface adapter development

• Indirect costs: travel to Detroit for testing

• Sunk costs: interface for previous generation, T-Mobile integration

• Learning curve: already tested and integrated once before

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Reserves

• Reserves are dollars included in a cost estimate to mitigate cost risk by allowing for future situations that are difficult to predict

• Contingency reserves allow for future situations that may be partially planned for• AKA “known unknowns”

• Examples: employee vacations, employee turnover

• Management reserves allow for future situations that are unpredictable• AKA “unknown unknowns”

• Examples: illness, natural disasters, weather

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Roadmap

• Introduction and case study overview

• Principles of cost management

• Estimating costs

• Determining the budget

• Controlling costs

• Software and tools

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Planning Cost Management

• Developing a cost management plan requires the following inputs:• Expert judgment

• Analytical techniques

• Meetings

• These will drive a cost estimation – a variety of techniques for predicting how many resources will be required to complete an activity or collection of activities (project)

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Types of Cost Estimates

• Rough order of magnitude (ROM) is an estimate of what a project will cost

• AKA swag, ballpark estimate, or guesstimate

• Accuracy is typically -50% to +100%, though may be much wider

• Some IT professionals automatically double estimates for software development

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Types of Cost Estimates (cont)

• A budgetary estimate is used to allocate money into an organizations budget• Many organizations develop budgets at least two years into the future

• More accurate than ROM -10% to +25%

• A definitive estimate provides an “accurate” estimate of project costs• Made closer to project completion

• Accuracy -5% to +10%

• Based on hard facts, such as cost of hardware

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Table 7-2: Types of Cost Estimates

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Case Study – Cost Estimates

• At project inception, provided a ROM estimate for project costs for all impacted systems• Level of effort

• Later, provided definitive cost based on level of effort plus• Tools

• Travel

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Cost Management Plan

• A cost management plan is a document that describes how the organization will manage cost variances on the project• Based on estimation, but acted on through monitoring and controlling

• Labor costs are a large percentage of total project cost (time = money)• Note that labor cost per resource (run rate) is often much higher for

contractors than full time employees

• Example: $45/hr FTE, $75/hr contract

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Sample Headcount (Table 7-3)

Maximum departmental headcounts by year for ResNet (Northwest Airlines)

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Cost Estimation Tools & Techniques

• Developing a cost estimate is difficult, but can be made easier with tools and processes

• Will discuss:• Analagous cost estimating

• Bottom-up estimating

• Parametric modeling

• Cost of quality

• Software

• Vendor bid analysis

• Reserve analysis

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Estimation Techniques

• Analogous estimates use the actual cost of a previous, similar project as the basis for estimating the cost of the current project• AKA top-down estimate

• Less costly than other techniques, but may be less accurate

• Bottom-up estimates involve estimating individual work items (activities) and summing to the project total• Preferred if there is a detailed WBS available

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Estimation Techniques (cont)

• Parametric modeling uses project characteristics (parameters) in a mathematical model to estimate project costs• Example: cost per line of code based on difficulty, talent, and size

• Most reliable when model has empirical input for parameters

• Downside: can be more inaccurate than other models if executed incorrectly (lack of experience)

• COCOMO II is a well-known example of a parametric model for development costs• http://csse.usc.edu/tools/COCOMOII.php

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Case Study – Estimation Techniques

• Question: what type of modeling would be most effective for the 500e project? What was actually used?

• Answer: bottom-up estimation was used, and was probably the best choice

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Estimation Challenges

• Estimates are often done too quickly

• Many people asked to do estimation lack experience

• Human beings are biased towards underestimation -> overrun

• Most challenging to balance, management wants accuracy

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Sample Cost Estimate

• Task: create a cost estimate to upgrade the telematics unit in the next generation of Fiat 500e electric vehicles

• Overview:• Upgrade modem from 2G T-

Mobile to 4G LTE Sprint

• Change interface from legacy NGTP to lightweight messaging

• All changes must be fully qualified before VP-A build date

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Sample Cost Estimate Assumptions

• Work breakdown structure (WBS) exists

• Testing is 10% of development costs

• Risk and overhead is 10% of development costs• Reserves, project management, architecture

• An inventory of required tools will be generated and quoted

• Three weeks of on-site work in Detroit will be required

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Sample Cost Estimate (cont)

• Development costs• WBS contains four development activities:

• TCU client re-write• 3 contract resources for 3 weeks

• Adapt provisioning portal to support new embedded SIM provider• 1 full time resource for 1 week

• Write service adapter for current production units (sunsetting existing dispatcher)• 5 contract resources for 8 weeks

• Add components to rights management for new model support• 1 contract resource for 1 week

• Contract run rate is $75/hr

• Full time run rate is $45/hr

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Sample Cost Estimate (cont)

• Tool support:• Develop new simulations for new vehicle (testing)

• Outsourced for $15,000

• Vehicle diagnostic tool for logging vehicle messages• Licensing cost of $10,000

• Benchtop fabrication (for testing TCU client prior to vehicle integration)• Outsourced for $7,000

• Travel costs:• 3 round trips flights to Detroit and 15 hotel nights

• $5,000

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WBS Items #Units/hrs Cost per Subtotals Level 2 Totals % of Total

1. Development $151,800 61%

TCU Client 360 $75 $27,000

Provisioning 40 $45 $1,800

Legacy adapter 1600 $75 $120,000

Rights management 40 $75 $3,000

2. Tools $32,000 13%

Simulation 1 $15,000 $15,000

Diagnostic tool 1 $10,000 $10,000

Benchtop 1 $7,000 $7,000

3. Travel $5,475 2%

Flights (roundtrip) 3 $800 $2,400

Hotel nights 15 $130 $1,950

Per diem 15 $75 $1,125

4. Testing $18,928 8%

10% of development N/A N/A $18,928

5. Project management $18,928 8%

10% of development N/A N/A $18,928

6. Reserves $22,713 9%

10% of other estimates N/A N/A $22,713

TOTAL COST ESTIMATE $249,84339

What could be improved?

• Estimation assumed 40 hours work weeks for contract labor

• Break out design and architecture from project management

• No hard datapoints based on previous experience• Dependent on learning curve

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Roadmap

• Introduction and case study overview

• Principles of cost management

• Estimating costs

• Determining the budget

• Controlling costs

• Software and tools

41

Project Budget Overview

• Determining the project budget involves allocating the project cost estimate to individual work items over time (WBS)

• Budgeting generally includes:• Headcount (FTE + Contract)

• Supplier costs

• Travel

• Deprecation

• Rent/leases

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Cost Baseline

• A cost baseline is a time-phased budget that project managers use to measure and monitor cost performance

• Use cost estimates for major activities to create

• Cost budgeting may result in updates to the cost management plan (monitor and controlling)

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WBS Items 1 2 3 4 5 6 7 8 9 10 11 12 Totals

1. Development $151,800

TCU Client $3,462.50 $6,925 $3,462.50 $3,463 $3,463 $3,463 $3,463 $3,463 $3,463 $3,463 $3,463 $3,463 $27,700

Provisioning $1,800 $1,800

Legacy adapter $15,000 $30,000 $15,000 $15,000 $15,000 $15,000 $15,000 $15,000 $15,000 $15,000 $15,000 $15,000 $120,000

Rights management $3,000 $3,000

2. Tools $32,000

Simulation $15,000 $15,000

Diagnostic tool $10,000 $10,000

Benchtop $7,000 $7,000

3. Travel $5,475

Flights (roundtrip) $2,400 $2,400

Hotel nights $1,950 $1,950

Per diem $1,125 $1,125

4. Testing $18,928

10% of development $4,732 $9,464 $4,732 $18,928

5. Project management $18,928

10% of development $1,577 $1,577 $1,577 $1,577 $1,577 $1,577 $1,577 $1,577 $1,577 $1,577 $1,577 $1,577 $18,928

6. Reserves $22,71310% of other

estimates $1,893 $1,893 $1,893 $1,893 $1,893 $1,893 $1,893 $1,893 $1,893 $1,893 $1,893 $1,893 $22,713

$249,84444

Sample Baseline

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Roadmap

• Introduction and case study overview

• Principles of cost management

• Estimating costs

• Determining the budget

• Controlling costs

• Software and tools

46

Project Cost Controlling

• Controlling project costs includes monitoring cost performance, cost impact of changes, and stakeholder communication.

• Outputs include:• Work performance measurements

• Budget forecasts

• Organizational process asset updates

• Change requests

• Project management plan updates

• Product document updates

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Earned Value Management

• Earned value management (EVM) is a project performance measurement technique that integrates scope, time, and cost data• In short: actuals vs forecast

• Uses baselines as input

• A baseline is the original project plan plus approved changes

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Key EVM Components

• Planned value (PV) is the portion of approved total cost estimate planned to be spent on an activity during a given period• AKA budget

• Actual cost (AC) is the total direct and indirect costs incurred in accomplishing work on an activity during a given period• AKA actuals

• Earned value (EV) is an estimate of the value of the physical work actually completed• Essentially a monetary representation of all work complete to date

• Ratio of performance (RP) is the ratio of actual work completed to the percentage of work planned

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EVM Components (cont)

• Cost variance (CV) is the earned value minus the actual cost

• Schedule variance (SV) is the earned value minus the planned value

• Cost performance index (CPI) is the ratio of earned value to actual cost• Used to estimate the projected cost of completing the project

• Schedule performance index (SPI) is the ratio of earned value to planned value• Used to estimate the projected time to complete the project

• Estimate at completion (EAC) is an estimate of what it will cost to complete the project based on performance to date• Can be done for schedule as well

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Table 7-5: Earned Value Formulas

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Table 7-4: Earned Value Calculations

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Figure 7-5: Earned Value Chart (Five Months)

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Global Issues

• EVM is used worldwide, and it is particularly popular in the Middle East, South Asia, Canada, and Europe

• Most countries require EVM for large defense or government projects

• EVM is also used in such private-industry sectors as IT, construction, energy, and manufacturing.

• However, most private companies have not yet applied EVM to their projects because management does not require it, feeling it is too complex and not cost effective

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Project Portfolio Management

• Utilizing a portfolio for related projects enhances cost management by providing historical data

• The five levels of portfolio management:• Put all your projects in one database

• Prioritize the projects in the database

• Divide projects into two or three budgets based on type of investment

• Automate the repository

• Apply modern portfolio theory including risk-return tools that map project risk on a curve

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Case Study – Portfolio Management

• The Fiat 500e upgrade project is actually a relatively small project in connected vehicle portfolio

• Other major projects:• Infotainment variant support

• Remote diagnostics

• Model support (Chrysler, Dodge, Jeep, RAM, SRT, Fiat)

• Platform modernization

• Draw from all to enhance cost estimation accuracy

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Roadmap

• Introduction and case study overview

• Principles of cost management

• Estimating costs

• Determining the budget

• Controlling costs

• Software and tools

57

Cost Controlling Software

• Microsoft Project 2007• Assign cost to resources

• Track actuals to forecast (EVM)

• Spreadsheets

• Using software empirically has benefits (2008 Gantry Group study)• Improved project timeliness by 45.2%

• Reduced time spent on status reporting by 43%

• Reduced time spent on labor capitalization reporting by 55% (3.6 hrs/report)

• Decreased time to sign-off for new projects by 20.4% (8 days)

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PRESTO

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Chapter Summary

• Project cost management is a traditionally weak area of IT projects, and project managers must work to improve their ability to deliver projects within approved budgets

• Main processes include• Plan cost management

• Estimate costs

• Determine the budget

• Control costs

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